The Math and Logic Behind Apple’s Deal with Verizon

By John Martellaro

Jan 11th, 2011 2:32 PM EST

Apple has made a smart business decision about the impact of adding Verizon as a carrier, and the net result must be an expected increase in iPhone sales and an increase in market share. A few disgruntled AT&T customers who defect aren’t going to offset that.

Understanding the financial means and intentions of your customers is key to any business strategy, but listening to some people, you’d think that Apple won’t gain much market share against Android because of millions of defections from AT&T. It’s just not going to go that way, and here’s why.

Courtesy: Apple

The Numbers Game

First, dissatisfaction with the AT&T network is one of those areas where a small number of people can make a big fuss, and that catches the attention of news reporters. In fact, AT&T’s churn rate has been falling, and is just over one percent. (The churn rate is the percentage of customers over a period of time who cancel their service and move to another carrier.) If AT&T’s customers were as universally angry as on might be led to believe, then the churn rate would be a lot higher. People know that AT&T is working to improve their network, and they love their iPhones.

Next, current AT&T customers have a sober decision to make when it come to defecting to Verizon. Do those current customers really want to move to a Verizon iPhone that can’t do concurrent data and voice, can’t be used overseas, and which, in principle is slower? (AT&T uses HSPA 3G which is faster than Verizon’s EV-DO network.) A little reading of the tech news and a review of their AT&T contract will give them pause. It’ll cost US$325 to break their AT&T contract, for starters, pro-rated down US$10/month. My take is that not many, percentage-wise, will pay that price just to jump to Verizon. If they were that unhappy, they would have already switched — if they could.

On the other hand, there are lots of reasons for Verizon customers to dump Android or perhaps their older feature phone contracts to get an iPhone. The drool-factor of the iPhone hasn’t gone away, and Verizon is well aware of the pent up demand for the iPhone based on feedback from customers. Another good reason to have a Verizon iPhone is that it has the same OS as their iPad, an item also available from Verizon. That’s not something to be overlooked. Breaking the current Verizon contract to get an iPhone for the first time, with breathless anticipation, is a lot more compelling than breaking an AT&T contract to move from an iPhone 4 to, well, an iPhone 4. And an inferior one, in some respects, at that.

This doesn’t ignore the fact that Verizon wants to steal customers from AT&T, and they’ll try to make it worthwhile. But the churn rate doesn’t have to change much, a percentage point or so at most, to become a sweet deal for Verizon. We’re talking a million customers here — compared to the ten million plus iPhones Verizon customers are expected to buy this year.

The net-net is that only a small percentage of AT&T’s iPhone customers will defect to Verizon while a much larger percentage of Verizon’s customers will move to an iPhone. If that weren’t the case, the whole Verizon adventure by Apple would be pointless.

If we need any further evidence, it comes from an Apple executive. During Apple’s Q2 earnings report on Apri 20, 2010, Tim Cook commented on adding foreign carriers, and I reported on his observation: “In every case, in foreign countries, where Apple changed from exclusive agreements with carriers to non-exclusive agreements, market share went up. The only remaining exclusive agreements with carriers are the U.S., Germany and Spain.”

There’s no particular reason why that shouldn’t happen in the U.S., and the result will be that Apple gains considerably from the Verizon deal with more total smartphones sold and larger market share. And because the arrangement with Verizon is reported to be non-exclusive, I expect, after a suitable period of time, Apple will pour it on with T-Mobile and/or Sprint.